Circular Letter No. 9 (1994)

August 11, 1994


All Licensed Life Insurers, Financial Guaranty Insurance Corporations and Accredited Life Reinsurers


Synthetic Guaranteed Investment Contracts

Several life insurers have requested that the Department approve the issuance of synthetic guaranteed investment contracts either as a group annuity contract, a funding agreement or an ancillary activity. It is the Department’s opinion that such contracts constitute financial guaranty insurance of a type which is not authorized by law and may not be issued in New York. Accordingly:

(1)  A domestic insurer is prohibited from issuing synthetic guaranteed investment contracts or similar arrangements either in New York or outside this state.

(2)  A licensed foreign insurer is prohibited from issuing synthetic guaranteed investment contracts or similar arrangements in New York.

(3)  Pursuant to § 1106 of the Insurance Law, a licensed foreign insurer may not issue such contracts outside of New York unless it obtains a determination from the Superintendent that the issuance of such contracts would not be prejudicial to the best interests of the people of this state.

(4)  An accredited life reinsurer may not issue such contracts outside of New York without having provided to the Superintendent satisfactory evidence that it will continue to meet the applicable standards of solvency required in this state.

The term "synthetic guaranteed investment contract" refers to a contractual arrangement between a pension plan sponsor and an insurer in which the insurer "wraps" a book value accounting guarantee around a portfolio of assets owned by the pension plan sponsor. Under the contract, the insurer guarantees to pay the book value of the assets, regardless of the actual market value of the supporting assets owned by the plan, upon the occurrence of specified circumstances which require benefit payments to plan participants. These arrangements have also been referred to as "wrap contracts".

Some of the proposed synthetic guaranteed investment contracts have been modeled after benefit responsive separate account products offered by life insurers. Such products typically guarantee principal and interest with the interest rate periodically reset to adjust for differences in the contract’s book value and the market value of the underlying assets. However, unlike the separate account products, the insurer does not own the asset portfolio wrapped by the synthetic contract.

Under an alternative arrangement, which insurers have argued constitutes a non-insurance product ancillary activity, the insurer acts as an investment advisor or investment manager and provides guarantees as to the sufficiency of plan assets by guaranteeing the purchase of plan assets at book value in order to ensure that the pension plan can meet its benefit obligations to plan participants.

It is the Department’s view that all of these proposed arrangements constitute doing an insurance business within the meaning of Insurance Law Section 1101(b)(1)(A), by making or proposing to make, as insurer, any insurance contract. The Department has long held that a contract covering the decline in the market value of securities not owned by the insurer constitutes doing an insurance business, and that such contracts are not authorized under Section 1113 or any other provision of the Insurance Law. We see no distinction between the proposed arrangements and such unauthorized contracts. Specifically, synthetic guaranteed investment contracts are not annuities or funding agreements, and are not substantially similar to either, because funds are not deposited with nor accumulated by an insurer under the contract. Such contracts also are not permissible as an ancillary activity. Therefore, they may not be written by a life insurer.

Since the enactment of Article 69 of the Insurance Law, the Department has determined that these types of contracts are financial guaranty insurance, but of a kind or kinds not authorized by law, even for monoline financial guaranty insurers operating pursuant to Article 69. The insurer’s obligation under these contracts is to pay a loss as a result of (depending upon the nature of the assets) changes in the levels of interest rates [Section 6901(a)(1)(B)] or changes in the value of specific assets or commodities [Section 6901(a)(1)(D)]. In some cases, if the fund invests in non-U.S. assets where the rate of exchange of currency becomes relevant, subparagraph (C) of Section 6901(a)(1) may also be involved. None of these events may be insured pursuant to Article 69.

Furthermore, the Department will not support legislation authorizing the issuance of synthetic guaranteed investment contracts by life insurers because we believe that such contracts cannot be effectively regulated and therefore, pose an unfair and unreasonable risk to the life insurers’ general account policyholders.

The Department believes that once a book value guarantee of assets is issued by an entity other than the owner of those assets, the investment manager (whether or not affiliated with the insurer) may be compelled to manage those assets for the sole benefit of the plan participants without the normal fiduciary restraints that would be exercised if the plan participants bore the risk of loss of value to those assets. Investment practices by the investment manager must inevitably reflect this fact. Contractual safeguards running from the pension plan sponsor or investment manager to the issuing insurer may either be legally unenforceable or unlikely to be enforced by the insurer because of business leverage exercised by large corporate sponsors or managers.

In addition, any attempt by a state insurance regulator to impose reasonable regulatory safeguards for the benefit of general account policyholders would be subject to challenge under the preemption provisions of the Employee Retirement Income Security Act of 1974 (ERISA) as conflicting with the rights of plan participants and the fiduciary duties owed to them under the Act. In the view of the Department, non-ownership of the assets by the issuing life insurer makes the success of any such challenge likely.

The Department is unaware of any authority, judicial or otherwise, which indicates that a state law regulating plan assets, or agreements affecting the assets, could withstand a preemption challenge under ERISA. Accordingly, it is unlikely that either the insurer or the Department could impose reasonable and enforceable safeguards affecting the management of the assets wrapped by the synthetic guaranteed investment contract.

The Department has approved contracts with book value accounting guarantees similar to the proposed contracts, but where the assets are owned by the insurer and held in a separate account. The separate accounts may be pooled or non-pooled separate accounts and are subject to the cash flow testing or asset maintenance requirements of either Regulation No. 126 (11 NYCRR 95) (Valuation of Annuity and Single Premium Life Reserves) or No. 128 (11 NYCRR 97) (Market Value Separate Accounts Funding Guaranteed Benefits; Separate Account Operations and Reserve Requirements).

Pursuant to Section 4240(a)(5) and (12) of the Insurance Law, separate account contracts may provide that the assets of the separate account shall not be chargeable with liabilities arising out of any other business of the insurer. The inclusion of such language in a separate account agreement insulates the assets of such separate account from claims of other creditors of the insurer. Section 7435(b) of the Insurance Law expressly provides that claims under such insulated separate account agreements "shall be satisfied out of the assets in the separate account equal to the reserves maintained in such account for such agreements and, to the extent, if any, not fully discharged thereby, shall be treated as a class four claim against the estate of the life insurance company". The "estate of the life insurance company" is defined in Section 7435(c)(1) to exclude any assets held in separate accounts that, pursuant to Section 4240, are not chargeable with liabilities arising out of any other business of the insurer, such as any general account liability.

Please acknowledge receipt of this letter to Martin F. Carus, Assistant Deputy Superintendent & Chief Examiner, Life Insurance and Companies Bureau, 160 West Broadway, New York, NY 10013

Very truly yours,

Superintendent of Insurance